While some companies are likely to come out favorably in the near term, we focus on long-term impacts to find who most benefits and who can navigate a difficult environment in the interim.
What adjustments have you made to your portfolios in light of the choppy markets so far in 2022?
In U.S. Value, we consistently look to invest in quality companies at reasonable valuations. During this volatile environment, alpha, rather than beta, will be a critical component to generate returns.
Within the Consumer sector, we added to durable brands that sold off on fears of European exposure and perceived FX risk, as investors were overdiscounting the true earnings potential of companies such as Pepsi. We have confidence that they can navigate given their strong track record of risk management.
We’ve been active in Energy and Industrials by rotating out of winners into laggards that have company-specific drivers. Our overweight in Energy has certainly worked given rising oil prices, and we’ve taken profits in Chevron. On the flipside, we initiated ExxonMobil, which had lagged due to its late adoption of quality governance practices such as curtailing production. We believe it has finally come around with the help of an activist investor, and its formidable balance sheet and defensive attributes should bode well going forward.
Within Industrials, we eliminated Stanley Black & Decker and added to UPS, which also has defensive characteristics and a competent new management team.
While we bulked up our Healthcare exposure over the last year as the sector meaningfully underperformed, we continued to selectively add to it, even after its better performance in 2022. We’ve found strong franchises such as Vertex and Humana, where investors seem to be looking past underlying business strength and instead are focusing on short-term issues, causing these stocks to trade at reasonable valuations.
Does a more hawkish Federal Reserve (Fed), in combination with a flattening yield curve, shift your view on financials?
Financials continue to be our largest sector exposure, but we acknowledge there’s been a sentiment shift to the negative. The risks are harder to ignore: a U.S. recession, higher credit costs, stickier inflation and declining mortgage businesses (to name a few!). However, it seems like some of the positive data during this earnings season so far is being overlooked: net interest margins doubling fourth-quarter projections, stronger loan growth and healthy credit quality.
In sum, we’re comfortable with our positioning, but will continue to gather facts as companies report earnings.
What is your outlook on the cyclical sectors from here, keeping in mind all of these cross-currents?
While the portfolio has little direct revenue exposure tied to Russia/Ukraine, there are impacts for the U.S. economy. We remain steadfast in our approach of investing in companies that have pricing power, and we are keeping a watchful eye on any signs of weakening demand. While some companies are likely to come out favorably in the near term, we focus on long-term impacts to find who most benefits and who can navigate a difficult environment in the interim.
We’ve felt the pain of rising input costs within the Materials sector, such as in Air Product & Chemicals, an industrial gas company, as its European operations were impacted by elevated natural gas prices. While its margins have been hit short-term, we feel comfortable that it will able to pass through prices in the future. Within Industrials, we took profits from Aerospace and Defense companies, such as Northrup Grumman, which have exhibited excess strength on the premise that defense budgets may expand in light of the war.
How has the sell-off in the tech and communications sectors impacted your ability to find new names?
We’ve been net sellers of high-growth stocks on valuations, such as Microsoft, Alphabet and Apple over the last few years. However, volatility in the first quarter allowed us to initiate Meta Platforms. Meta missed on fourth-quarter earnings and lowered guidance due to TikTok competition, Apple privacy impacts (IDFA) and enhanced CAPEX spending for virtual reality investments. We viewed this as an opportunity to access a strong business model, with an excellent balance sheet and free cash flow yield, at a very attractive price.
With consumer sentiment at a historical low, how are you navigating the consumer sector?
We’ve been positive on the consumer over the last year, but persistent inflation and weaker sentiment make us incrementally cautious. We are staying diversified in stocks with independent catalysts that we view as standalone opportunities. For example, off-price retailers, such TJX Companies, are likely to benefit from supply chain disruptions, as higher costs and lag times will impinge on regular retailers, but directly benefit TJX, which can receive cheap inventory with less focus around seasonality.
All in all, there are still opportunities, and we are watching how consumers will shift their spending patterns to make investment decisions going forward.